Question

Explain and illustrate the following statement: “ A deficit on the balance on current account will impose severe constraints upon domestic economic policies”

Answer 1

Current account is an account which records all the transactions related to the export and import of goods and services along with the unilateral transfers during a given time.

Deficit in BOP occurs when debit side is more than credit side, in other words foreign exchange payments are more than foreign exchange receipts.This means the outflow of foreign exchange.

However it is correct to say that deficit on the BOP will impose severe constraints upon domestic economic policies because it order to correcr the BOP,the following policies are undertaken:

1. Deliberality reducing the consumer spending by increasing the taxes or reducing the availability of credit. This will reduce the imports and thereby the BOP deficit can be recovered. But this will result into unemployment and recession.

2. Reducing the value of country's currency.But this will trigger the cost push inflation which will increase the price of imported goods.

3.Imposition of tarrif and quotas on imports. But this will not work in the long run.